Oct. 5 (Bloomberg) -- Italy’s credit rating was cut by
Moody’s Investors Service for the first time in almost two decades
on concern that chronically weak growth will make it difficult to
reduce the region’s second-largest debt while fallout from the
region’s debt crisis boosts financing costs.

Moody’s lowered Italy’s rating three levels to A2 from Aa2,
with a negative outlook, the New York-based company said in a
statement yesterday. The action comes after Standard & Poor’s
downgraded Italy on Sept. 20 for the first time in five years.
Italy was last cut by Moody’s in May 1993.

Moody’s also said that all European countries with ratings
below the top mark of AAA may face downgrades as many euro-area
governments are facing “a profound loss” in investor
confidence as policymakers have failed to stop debt-crisis
contagion. Italy’s borrowing costs have fallen from euro-area
highs in August after the European Central Bank began buying its
bond to stop the slide in the country’s debt.

Rating Risks

“All but the strongest euro-area sovereigns are likely to
face sustained negative pressure on their ratings,” Moody’s
said. “Consequently, Moody’s expects fewer countries below AAA
to retain high ratings.” It added that “there are no immediate
pressures that could cause downgrades for Aaa-rated countries.”

Moody’s decision “was expected,” Prime Minister Silvio
Berlusconi’s office said in an e-mail yesterday. “The Italian
government is working with the utmost commitment to meet its
budget targets.”

The yield on Italy’s 10-year notes rose 5 basis points 5.53
percent today, leaving the difference investors to hold Italian
bonds instead of benchmark German bunds at 377 basis points. The
cost of insuring Italian debt against default has more than
doubled since the start of the year. The euro traded at $1.3291
at 9:53 a.m. in Rome, down 0.4 percent on the day.

Italy joined Spain, Ireland, Portugal, Cyprus and Greece as
euro-region countries whose credit rating has been cut this
year. Unlike Ireland and Portugal, which followed Greece in
seeking bailouts from the European Union and the International
Monetary Fund, Italy had until this summer managed to skirt the
worst of the fallout from the debt crisis.

Funding Costs

The reasons for the downgrade include “increased funding
risks for euro area sovereigns in general, such as Italy, with
high levels of public debt,” Alexander Kockerbeck, a Frankfurt-based sovereign debt analyst with Moody’s, said in an interview
yesterday. He also cited the risk of slower growth “due to
macroeconomic structural weaknesses, and on top of that, a
weakening global growth outlook.”

Italy, with a debt of more than 1.9 trillion euros (2.5
trillion), has more than 66 billion euros in bonds and bills
maturing this year and has more than 200 billion euros in
financing needs in 2012, Moody’s said. Still, Italy’s budget
deficit is lower than many of its higher rated peers and a 54
billion-euro austerity package passed last month aims to
eliminate the budget gap in 2013.

“The more menacing the euro-zone crisis becomes, the
blurrier the distinction between illiquidity and insolvency for
both sovereigns and banks, said Nicholas Spiro, sovereign and
head of Spiro Sovereign Strategy, a consulting firm in London.
‘‘Italy’s relatively strong budgetary position counts for
little at a time when investors are increasingly skittish about
high levels of debt.’’

Calls for Resignation

The downgrade may aggravate a volatile political situation.
Berlusconi, battling to keep his ruling coalition together,
faces five trials and calls from Italian employers, his long-time backers, to step down as a decade of virtually no economic
growth undermines debt reduction. Italy’s debt of about 120
percent of gross domestic product is second in the region only
to Greece.

The Moody’s cut may have further strained relations between
Berlusconi and his Finance Minister Giulio Tremonti. The
ministers knew in advance of the rating cut and failed to inform
Berlusconi, who told allies that Tremonti wanted to use the
downgrade to discredit the premier, newspaper la Repubblica
reported. The Finance Ministry wouldn’t comment on the report.

‘Fragile’ Government

Tremonti yesterday signaled that early elections might help
ease Italian borrowing costs when he said after a meeting of
European finance chiefs that Spain’s risk premium over Germany
was lower than that of Italy because the government there had
called for an early vote in November.

S&P in May and Moody’s in June warned that they may
downgrade Italy, saying the government may miss fiscal targets.
Moody’s extended its review of Italy for one month on Sept. 16,
four days before S&P cited growth concerns and Berlusconi’s
‘‘fragile” government as reasons for its downgrade.

Italy’s economy expanded an average 0.2 percent annually
from 2001 to 2010, compared with 1.1 percent in the euro area.
Gross domestic product advanced 0.3 percent in the second
quarter from the three months through March, when it rose 0.1
percent, national statistics institute Istat said on Sept. 9.

On Sept. 20, the IMF cut its growth forecast for Italy,
saying it will miss its goal of erasing the deficit. Two days
later, the government cut its own forecast, while keeping its
commitment for a balanced budget in 2013.

Growth Forecasts

The Finance Ministry said the euro-region’s third-biggest
economy will grow 0.7 percent in 2011 instead of the 1.1 percent
forecast in April and 0.6 percent in 2012 rather than 1.3
percent. That compares with the growth forecasts by the IMF of
0.6 percent this year and 0.3 percent next.

The ministry also forecast a budget deficit of 3.9 percent
of GDP this year, 1.6 percent next year and 0.1 percent in 2013.
The IMF projected the deficit to fall to 4 percent of GDP in
2011, 2.4 percent in 2012 and 1.1 percent in 2013.

Berlusconi has pushed through two packages of deficit cuts
since mid-July totaling about 100 billion euros. Measures
included raising the value-added tax by one percentage point to
21 percent and a levy on incomes of more than 300,000 euros to
balance the budget by 2013. The second, announced on Aug. 5, was
a condition of ECB support.

The negative outlook on Italy announced last month by S&P
means there’s a one-in-three chance that the company will lower
the nation’s rating again within the next 12 to 18 months,
Moritz Kraemer, S&P’s managing director of European sovereign
ratings, said Sept. 20.